The knee-jerk panic about assuming fiduciary responsibility is largely derived from sweeping generalizations that are untrue in most cases and exaggerated in many others. The dread of fiduciary liability is based on what can happen in the worst case. If this logic was applied to air travel, there would be no airline business. If applied to driving, there would be no automobile industry.

There are dangers in these and while fear exists, it does not rise to the level of neverfly or neverdrive. Why then is there a dominant neverfiduciary community?

The reality of fiduciary risk is that the potential danger varies widely and can be mitigated by reasonable practices.

Definition

A greater understanding of the fiduciary risk is fundamental to deciding whether to take on a fiduciary role or to avoid that responsibility. The essential fiduciary requirement is the responsibility to act in a client’s best interest without regard for personal gain. The responsibility is limited to a prudent course of action based only on facts that were known at the time of the action. These fiduciary requirements mean that a fiduciary is protected in three ways:

• Fiduciaries bear no responsibility for outcomes that are caused by events or circumstances after the fiduciary action.
• Arrangements must be in the fiduciary’s best interest before assuming the responsibility.
• Fiduciaries must be able to show that the course of action taken was prudent.

While these three protections do not eliminate all potential liability, when used consistently exposure is reduced to a level that is often less risky than not being a fiduciary.

The Fiduciary Choice

Assuming fiduciary responsibility is always the choice of the individual or institution that will have the fiduciary role and is not required by regulation or by clients. This choice is not a simple one since it involves adopting the three protections described above and others that regulations may impose.

A fiduciary may be mandated for certain activities. When fiduciaries are required for an activity, the choice becomes whether to engage in that activity. In this case, the choice of engaging in the fiduciary activity indirectly forces the fiduciary choice.

Variations

The potential liability of assuming fiduciary responsibility depends on what services the fiduciary provides and the potential for regulatory violation and/or client losses. The potential liability for a fiduciary to recommend an asset allocation of diversified mutual funds for a client with $1,000 of investable assets is small and increases very slowly over time. Contrast this with managing a $10 million portfolio of alternative investments, options and commodities.

Conversely, liability is lowered by the number of potential courses of action. Examples are a) a recommendation to roll or not to roll assets out of a retirement plan or b) selecting from a limited menu of choices.

Such variations and the myriad of possibilities must be considered before assuming fiduciary responsibility for a client.

Opportunities

The individual or institution that takes on fiduciary responsibility for all clients enjoys competitive advantages that enable higher compensation for a superior standard of care.

Most clients assume, expect, desire, prefer or demand a standard in which their own interests are the motivation for actions.

Fiduciaries who make it abundantly clear that all of their actions are driven by the client’s best interest and never by the desire for personal gain are in a position to win every client who assumes, expects, prefers or demands this standard.

Success as a fiduciary requires that the standard of care is used as the central theme that raises the awareness of the existence of lower standards.

Vulnerabilities

The greatest vulnerabilities for a fiduciary are inadequacy and inconsistency.

The most frequent inadequacies are regulatory non-compliance, inadequate procedures or systems, lack of proper controls, failure to set reasonable expectations, failure to explain limitations on the standards of care and contradictions in contract terms.

Inconsistences generally occur when exceptional conditions arise. Under these conditions procedures are often bypassed and records poorly maintained.

Threats

Threats arise from two main sources, each having different motivation. There are regulators that seek to ensure compliance and there are clients (represented by attorneys) who seek to recover losses and inflict punitive damages.

Regulators focus on the regulations and guidance they have issued. Regulators have the power to shut down all or part of a business if violations are found.

The threat from clients increases when they lose money and therefore seek recovery. The threat from clients is expected to increase as plaintiffs discover vulnerabilities of fiduciaries.